Investment Termsheet Elements explained – 10 Things to watch out on your Termsheet

You would have worked really hard to get that termsheet in your hands which comes after pitching your idea to various investors and finally getting it liked by some investors and getting the termsheet from them. But not always all the termsheets are acceptable as they may include terms which can ruin your business. And to understand the termsheet, you have to get accustomed to the termsheet elements/terms used to describe it. Read What is Termsheet

What Termsheet Contains of –termsheet-elements-beware

  1. Valuation or Price per share – Before the investors can buy share in your company, your company should have some value to it and this is called as company valuation or Pre-money valuation. And this valuation is either valued by the investor or the market forces.   Example : If Pre-money valuation= Rs.100 and investor wants to invest Rs. 50 then Post money valuation=Rs.150 And check out how much will be founders and investors share after the investment using this awesome tool Founder share = 100/150(67%) and investor share = 50/150(33%)
  2. Liquidation Preference – Liquidation preferences define the division of profits between shareholders in the event of a sale of the company – regardless of equity ownership. This has two provisions 1) Investors can choose 1x, 2x, 3x ….10x returns 2) choose for no participation or Full participation Example : If a company sells for say  Exit amount = Rs. 200 and investor invested Rs.50 then before anybody takes the share, investor will take Rs.50 in case of 1x, Rs.100 in case of 2x etc and remaining Rs.150 (in case 1x) will be again shared between all the share holder(Investor will participate in this distribution if he has chosen for Full Participation in termsheet). Again you can calculate the exit scenarios in our Gizmo tool linked above.
  3. Board of Directors – Board structure : In this term you will decide who will be given how much power in making decisions for the company, and who will choose how many member that will form the board of directors. There will be provision for making the board consists of investor’s representatives, founder’s representatives and company representatives.
  4. Protective Provisions – VCs would like to have some veto-level control over a subset of actions the company could take, especially when it impacts the VC’s economic position. This condition will ensure that consent of the holders of at least a majority of the investors shall be required for any action
  5. Drag Along – In case an investor wants to sell his stake in a company he can force a founder and other investors to follow suit. The [holders of the Common Stock] or [Founders] and Series A Preferred shall enter into a drag-along agreement whereby if a majority of the holders of Series A Preferred agree to a sale or liquidation of the Company, the holders of the remaining Series A Preferred and Common Stock shall consent to and raise no objections to such sale
  6. Anti-Dilution – The anti-dilution provision is used to protect investors in the event a company issues equity at a lower valuation then in previous financing rounds.There are two varieties: weighted average anti-dilution and ratchet based anti-dilution. Full ratchet means that if the company issues shares at a price lower than the Series A, [What is Series A/B/C funding] then the Series A price is effectively reduced to the price of the new issuance. One can get creative and do “partial ratchets” (such as “half ratchets”or “two-thirds ratchets”) which are a less harsh, but rarely seen [source]
  7. Dividends –  Its kind of interest the investors want from the money invested. It can range up to 5%-15% of the sum invested by the investor which has to be given to them annually. It can be either cumulative or non-cummulative dividends.
  8. Pay to Play – In a pay-to-play provision, an investor must keep “paying” (participating proratably in future financings) in order to keep “playing”(not have his preferred stock converted to common stock) in the company. i.e., existing investor must invest in follow-on rounds to retain his rights
  9. Conversion – The VCs i.e., the preferred has the right – at any time – to convert its stake into common stocks.
  10. Vesting – Typically, stock and options will vest over some years. If the founders stock/equity vests over four years – that means that you have to be around for four years to own all of your stock or options.  If you leave the company earlier than the four year period, the vesting formula applies and you only get a percentage of your stock. It is a way for VCs to “control founders, their involvement, and their ownership in a company”

Investors are usually more experienced and are well equipped with their legal team which makes things very simple for them. So its important for you to be prepared equally.

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